Are CDs worth it?

In a nutshell

With low interest rates on checking and savings accounts, many investors are looking for alternatives to earn higher returns. One of these options is a certificate of deposit (CD).

• CDs offer a guaranteed interest rate for a set period of time, often from six months to five years.
• Many CDs charge a penalty for withdrawing your money before the end of the term.
• With interest rates expected to flatten, are CDs worth it?

In this article, we'll share what CDs are, the pros and cons of investing in them, and alternatives that you may want to consider when interest rates are flat.

What are CDs?

Certificates of deposit (CDs) are bank deposit products that offer a guaranteed interest rate for a stated period of time. In most cases, when the CD matures, the bank will roll over the CD at the current interest rate for the same period of time. For example, a one-year CD will roll over into a new one-year CD when it matures.

Because CDs lock up your money for a period of time, they generally offer interest rates that are higher than savings accounts. CD terms typically range from 30 days to five years. Most banks charge a penalty if you need to access your money before the CD term has matured.

Pros of investing in CDs

CD balances are insured by FDIC

Like other bank deposit products, CD balances are protected by FDIC insurance. These balances combine with your other bank deposits at that bank for up to $250,000 of insurance coverage in case the bank fails.

They offer guaranteed rates for fixed terms

When you purchase a CD, your interest rate is locked in for the duration of the term. No matter what happens to interest rates, your interest rate will not change until it renews. This feature gives many investors peace of mind when creating their financial plans.

Multiple terms available to match your timing

Because of the different term options available with CDs, you can choose a term that aligns with your goals. Some investors "ladder" their CDs so that one renews every six to 12 months so they have easy access to a portion of their cash without paying a penalty.

Some banks offer promotional CD rates and terms

As you shop CD rates, look for promotional offers that may provide higher rates or better terms. Some banks may offer promotional rates that are higher than longer CDs based on their funding needs. Examples of other promotions include the ability to deposit additional funds into your CD or make penalty-free withdrawals.

You can get more than $250,000 in FDIC coverage

FDIC insurance covers up to $250,000 per person at each bank. For some investors, this limit is too low for their savings needs. An entity called Certificate of Deposit Account Registry Service (CDARS) allows savers with more than $250,000 in cash to quickly open up additional CDs at multiple banks to maximize FDIC coverage. To use CDARS, ask if your local bank participates in the program.

Cons of investing in CDs

Penalty for early withdrawal

If you need access to your money before the CD matures, most banks charge a penalty. This could erase all of the interest you've earned and possibly eat into your principal. For CDs that mature in less than one year, the typical penalty is three months of interest; for CDs of one year or longer, the penalty is six months of interest.

Interest rates may not be competitive

Before locking your money for the CDs term, make sure that you evaluate your alternatives. While CD rates may be marginally higher than savings accounts, is it worth locking up your money for a small difference in rates? Many alternatives offer competitive rates without charging a penalty if you need to access your money. In some cases, you may find a higher rate with better liquidity.

Auto-renewal may lock in a low rate

When your CD renews, it will renew at the current rate for the same term. Banks are required to notify you ahead of time, but you may miss the notice. If rates have dropped, you may get locked into a lower rate than expected.

Some banks have minimum deposit requirements

Some CDs have no minimum deposit, but generally, in order to get the best interest rates, you may have to have a minimum deposit of several hundred or several thousand dollars. Some Jumbo CDs require a deposit of $100,000 or more.

When investing in a CD is worth it

After reading the pros and cons of investing in CDs, you may be wondering, "Are CDs worth it?" The answer depends on your goals, timeframe, and what makes up the rest of your portfolio. CDs provide a guaranteed rate of return for a defined period of time. The money is insured, but you cannot access it until the term matures without paying a penalty.

Investing in CDs is best for people who seek a higher return for a short period of time without exposure to stock market volatility. If you believe projections of flattening CD rates will ultimately result in lower rates, locking in at current rates may be beneficial.

Alternatives to CDs

If you're unsure if a CD is right for your portfolio, consider these alternative investment options that also provide recurring income.

• High-yield money market accounts. These accounts offer competitive interest rates with easy access to your money. Many have no minimum deposit requirement or monthly fees.
• Short-term U.S. Treasuries. Treasury bills are short-term government bonds with maturities that range from a few days to one year. They are sold at a discount and mature to their face value.
• Treasury inflation-protected securities (TIPS). These government bonds pay interest every six months, and their principal is adjusted by changes in the Consumer Price Index (CPI). Maturities offered are five, 10, and 30 years.
• Dividend stocks. Many investors choose dividend stocks for their recurring dividends and ability to participate in the growth of the stock market.
• Individual bonds. Bonds offer interest payments at regular intervals. While the value may decline if interest rates rise, if you hold the bond to maturity, you'll receive face value.
• Fixed annuities. Annuities are designed for retirement income. You can make regular withdrawals as needed or annuitize your balance to receive income for the rest of your life.
• Real estate investment trusts (REITs). REITs are a collection of real estate properties with professional management. By law, they must distribute at least 90% of their taxable income to shareholders to receive their preferred tax status.

The AP Buyline roundup

CDs are worth it for the right investor. They offer a guaranteed rate of return for a defined period of time. Terms range from 30 days to five years, which makes it easy to align its maturity with your goals. As a bank deposit product, your balances are guaranteed up to $250,000, but there are options to extend the coverage higher. CDs aren't for everyone, so there are numerous viable alternatives to help you reach your goals.